Gap profit drops 35%; forecast lowered

CHICAGO (MarketWatch) -- Gap Inc. turned in a 35% drop in fourth-quarter profit late Thursday, capping a year of sales turmoil and executive shake ups, and forecast lower fiscal-year results as it grapples with its future and folds the Forth & Towne concept.

The company also noted that it has decided to use a search firm to help it hire a new chief executive, underscoring the difficulty in finding a veteran merchant to lead the nation's largest apparel company.

On a conference call with analysts, executives said they will look to Gap Inc.'s heritage as it works to reshape its future.

"It's clear we have a lot of hard work ahead," Robert Fisher, the company's chairman and interim chief executive said, "but I believe that this company still has tremendous potential.

"For the coming year, our teams are focused on improving the fundamentals and stabilizing the business," he said. "Although we'll make progress along the way, it will take time to restore our financial performance to competitive levels. There is no quick fix."

The company, which operates the Gap, Old Navy and Banana Republic stores, struggled with sales and margins during the holiday-shopping season, a retailer's most-important period. As a result the San Francisco-based apparel giant
GPS, -1.78%
saw its earnings fall to $219 million, or 27 cents a share, compared with last year's income of $337 million, or 39 cents a share.

Total sales rose 2.2% to $4.93 billion, thanks mostly to an extra week in the quarter. Profit margins, however, declined, as the retailer had to take steep price discounts to clear excess merchandise at Gap and Old Navy stores.

Same-store sales, the industry's benchmark of growth, tumbled 7% in the aggregate. The Gap stores same-store sales were down 8% and Old Navy's were lower by 9%. Things were brighter at Banana Republic where same-store sales climbed 3% as the retailer extended its brand to "capitalize on accessible luxury positioning" to include handbags, a broader selection of shoes, and fragrances.

The results, however, managed to eke past Wall Street's forecast. Analysts reporting to Thomson Financial were looking for per-share earnings of 24 cents on sales of $4.89 billion, on average.

Gap Inc. started the new fiscal year last month with a number of unsettling changes, including a mass departure of senior executives and managers. The exodus was highlighted with the ouster of Chief Executive Paul Pressler and Gap's president of its North America division, Cynthia Harriss.

Marka Hansen, who spearheaded the so-far successful sales turnaround at Banana Republic last year, replaced Harriss and was on the call with analysts Thursday. Fisher, the son of Gap founder Donald Fisher, took on the chief executive duties until a new leader is found.

On Thursday, the company noted that it was in the "final stages" of choosing an executive search firm to help it find a CEO -- a job that analysts think will be a chore to fill. When Gap announced that Pressler was out, it said that it would rely on deep-seated retail mavens on the board to find a replacement.

When asked on the call if he would consider throwing his hat in the arena, Fisher said, "It's not my intention to be a candidate."

Earlier this week Gap admitted it made a mistake in trying to launch a new concept to grab more sales from women 35 years and older. The retailer said that it was shuttering the fledgling Forth & Towne concept and its 19 stores.

That will cost the company about 4 cents a share to the bottom line this year and Gap's shaved its diluted fiscal-year profit projection to a range of 76 cents to 86 cents.

At Thomson Financial, analysts had pegged earnings of $1.02 a shares, which don't include the Forth & Towne loss. But even if the 4 cents is stripped out of the estimate, Gap's forecast is notably narrower.

The company also noted Thursday that it is converting 45 Old Navy outlet stores to stand-alone stores, a process that began last month and is expected to be completed by October.

"Given the changing competitive environment, there is no longer a clear distinction between the two businesses," Chief Financial Office Bryon Pollitt said on the call. That has also led to the closing of a distribution center in Hebron, Ky.

Pollitt said the conversion and closing will cost about $6 million, but will save the company about $12 million annually.

Shares of Gap fell 16 cents to $19.03 ahead of the news but were rising modestly in after-hours trading.

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